Good Faith and Fair Dealing in Contract Enforcement

Contracts are promises, mutual promises: You do something (perhaps a service), and I'll do something in return (pay you, hopefully). Even written contracts that are hundreds of pages long can be summed up simply as "an exchange of promises." One of the great developments of Western Civilization is that aspect of the "Rule of Law" that government, through the system of civil courts, will enforce contract obligations. With few exceptions (such as contracts involving illegal activities), courts will require people to pay damages to their counter-party if the "breach" the contract by failing to fulfill their contract obligations.

A vast body of court decisions and statutes has developed concerning whether a party has fulfilled their contract obligations or "breached." You would think it a simple question to resolve. In the case of a written contract, courts will look to the language of the document and how the parties acted after the contract was formed to determine the parties' intent. Courts have wisely determined that these are a more reliable source than the oral testimony of witnesses who have a financial stake in the outcome of the trial.

So, courts put great weight on the language of the written contract and for centuries have required parties to fulfill their obligations and exercise their rights in strict compliance with the contract language. But exceptions have developed that have expanded obligations.

In the 20th century, courts began to soften the rigid approach to contract enforcement by introducing the concept of "good faith and fair dealing." These cases examined how a party to a contract performed and asked the question "Even if the contract language allows this type of conduct or performance, is this party violating the principles of good faith and fair dealing?"

Courts adopting this approach concluded that a party who enters into a contract assumes that his/her counter-party will reasonably try to carry out their obligations and will not try to do harm. Thus, courts have said that this additional obligation of good faith and fair dealing is "implied" in the contract.

Covell was a data processing salesman for Tymshare and was to be paid a salary-plus-commission. Commissions were based on an annual sales quota. Estimated commissions were paid monthly, with a hold-back for a year-end calculation. The contract allowed Tymshare to adjust the annual quota. Covell landed the U.S. Postal Service as a client for Tymshare. Anticipating the revenues from the Post Office, Tymshare set Covell's sales quota for 1980 at $1.2 million, but when the roll-out with the Post Office stumbled Tymshare generously lowered the sales quota to $815,000. In December 1980, Tymshare terminated Covell and at year-end made retroactive adjustments to his sales quota, taking back up to $1.2 million and depriving him of significant commissions.

Covell sued and the trial court found in his favor, concluding that the adjustment had been done in bad faith. On appeal, Judge Scalia noted that the contract permitted adjustments to sales quotas, but "even the permissible act performed in bad faith is a breach only because acts in bad faith are not permitted under the contract." Tymshare 727 F2d at 1150 n.3.

Thus, it was not a strict reading of the contract language that controlled the outcome, but an examination of the purpose of allowing quota adjustments. Was the exercise of this contract right (quota adjustment) serving a legitimate business purpose or merely meant to punish Covell?

Under modern contract law, there is a somewhat higher standard for performance of obligations. But beware: Principles of good faith and fair dealing are still a narrow exception to courts engaging in strict interpretation of rights and obligations based upon contract document language. In all cases, be careful and precise with the language.

Related Services

The materials provided herein include items that were created by MacDonald, Illig, Jones & Britton, LLP and are protected under U.S. Copyright Law. These materials may not be copied, duplicated, modified, or distributed without the express written permission of MacDonald, Illig, Jones & Britton, LLP. All rights reserved by MacDonald, Illig, Jones & Britton, LLP.